The Obama administration is seeking
to widen the scope of its proposal to overhaul the corporate tax
code, urging Congress to also change rules that allow some
businesses to take advantage of tax laws governing individuals.

U.S. Treasury Secretary Timothy Geithner told the Senate
Finance Committee Feb. 15 that Congress should “revisit” long-
standing rules that give businesses a choice of paying taxes as
a corporation or through a structure such as a partnership
through which they can report business income on individual tax
returns.

The recommendation, which Geithner repeated in a meeting
with reporters this week at Bloomberg News in Washington, would
affect income earned by the nation’s largest law firms,
investment partnerships and so-called S corporations. It would
more than double, to about $3 trillion, the amount of business
income potentially affected by tax-law changes.

“Congress has to revisit this basic question about whether
it makes sense for us as a country to allow certain businesses
to choose whether they’re treated as corporations for tax
purposes or not,” Geithner told Senate Finance Committee
members. Later in his testimony he said: “You have to look at
business taxes outside the corporate sector if you’re going to
do something sensible here.”

Obama called for a rewrite of business tax rules in his
State of the Union address on Jan. 25 and in his fiscal 2012
budget proposal released Feb. 14. The House Ways and Means
Committee, led by Michigan Republican Representative David Camp,
has held one hearing on revamping the nation’s tax system and
plans more.

Senate Finance Committee Chairman Max Baucus, a Montana
Democrat, has said that the first in a series of hearings on
rewriting the tax code will be held March 1.

Corporate Overhaul

Geithner’s suggestion confronts complaints by congressional
Republicans, including Camp, who say the administration’s
earlier focus on rewriting only the corporate code ignores how
other types of businesses are taxed. Camp has said Congress
should also examine the individual tax code because it affects
so many businesses.

A spokesman for Camp, Sage Eastman, said a tax code rewrite
should also simplify rules for individual taxpayers.

“You’ve left out in the cold individual Americans and
their families who are dealing with massive levels of complexity
and compliance costs both in terms of hours to comply and actual
dollars to comply,” Eastman said. “It still falls short of the
comprehensive reform that we need.”

U.S. businesses can pay taxes as a corporation, with a top
35 percent rate, or through structures that allow profits and
losses to be reported on owners’ personal tax forms. The top
marginal rate for individuals is also 35 percent. It is
scheduled to rise to 39.6 percent in 2013.

Tax Filings

Of 32.1 million U.S. businesses in 2007, 5.9 million opted
to file under the corporate code, with total taxes paid of just
under $1.4 trillion, according to the most recent data available
from the Internal Revenue Service. About 7 million partnerships
and so-called S corporations earned $484 billion and $976
billion, respectively. The rest of the businesses were sole
proprietorships that collectively earned $335 billion.

To some degree, an examination of both forms of business
taxation is unavoidable. Many business tax breaks, such as
accelerated write-offs for equipment, benefit both types of
filers. Eliminating a break in exchange for lowering the
corporate tax rate would lead to debate about whether non-
corporate businesses should be able to claim the deduction.

In an interview this week with reporters in Washington,
Geithner indicated that the question about maintaining multiple
tax classifications is more fundamental.

“What’s a little unique about our system relative to other
countries is we do give a lot of businesses the choice of how
their income should be taxed,” he told reporters. He also said
the administration’s oft-repeated condition that an overhaul
must raise as much revenue from corporations as is now collected
applies to all forms of businesses.

‘Revenue-Neutral’

“When we say revenue-neutral,” Geithner said, “we try to
mean it sort of generally across business income, not just
corporate.”

Pamela Olson, a tax partner at the law firm of Skadden,
Arps, Slate, Meagher & Flom LLP in Washington and a former
assistant secretary for tax policy at the Treasury Department,
said policy makers have long studied “the huge gap between
corporate and pass-throughs.”

“Congress may be forced to choose between eliminating the
double tax on corporate income or requiring all businesses to
pay a corporate-level tax,” she said.

Neal Weber, managing director of the Washington national
tax office of RSM McGladrey Inc., said that including non-
corporate businesses in talks about a corporate code rewrite
would alarm his clients, many of which are small and medium-
sized businesses.

“It strikes me that Secretary Geithner’s proposal to
potentially force businesses to be taxed as corporations runs
contrary to the administration’s objectives,” he said. “Most
small to mid-sized businesses in the U.S. are structured as
pass-through entities in order to avoid double taxation.”